Determinants of cross-country mergers and acquisitions

By Divya Narang & Priya Chetty on August 13, 2019

The 21st-century corporate world has witnessed the phase of globalization. It has led to technological advancement and the removal of trade barriers across countries. This is important as the competitive advantages of different organizations differ in terms of availability of raw material, investment, technology and so on. Therefore, in order to ensure long term growth potential, organizations have started forming cross country mergers and acquisitions (M&A). In contrast to the domestic mergers, cross country mergers help businesses in realizing the scope of new market opportunities. This is evident from the rise in the volume of cross border M&A.

Changing scenario of mergers and acquisitions (M&A)

Cross-country M&A volume exhibited a growth rate of 47% in 2007 as compared to 23% in 1998 (Erel, Liao, & Weisbach, 2012). The average deal size is also increasing. However, these M&A have potential challenges in the form of economic, legal and geographic differences. These challenges arise due to cross country effects such as technological advancement, economic conditions and the variation in the laws and regulations across the countries. Apart from this, the financial performance of each business could vary according to the liquidity or capital structure. There are many factors which affect the acquiring firm’s financial performance such as:

  • asset turnover ratio,
  • deal size,
  • size of the firm,
  • industry relatedness,
  • geographic expansion and,
  • R&D innovation.

There are many factors that determine a business’s decision to engage in an M&A deal. While some of these factors are country-specific, some are business-specific. In this context, the present article examines the country-specific and the business-specific effects that act as the determinants of cross-country M&A.

Corporate Governance as a country-specific determinant

Corporate governance refers to the set of central government’s rules and regulations that all businesses present in a country are expected to follow. Legal structures such as transaction costs, asymmetries of information, the agency, and governance-related factors may vary across countries that could significantly affect the acquirer’s decision (Liu & Wang, 2013). The accounting standards and regulatory environment affect an investor’s decision. 

For instance, the developed market acquirers can realize benefits through the weak legal requirements in developing countries (Bhagat & Brian, 2008). Therefore, the volume of M&As occurring in the country depends on the strictness regarding the accounting and regulatory environment in which the organization functions.

Economic conditions of a country act as an important determinant

The economic conditions of a country affect a business’s decision to engage in M&A activities. There are many macroeconomic indicators such as:

  • gross domestic product,
  • employment,
  • inflation and,
  • foreign direct investment inflows.

If these indicators show a favorable performance, it encourages an overseas investor to expand its business activities there. Of late, cross-country M&A has risen in terms of numbers and the value of acquisitions. In recent times, economically catastrophic events such as the stock market crash of 2000 and the global recession of 2008 led to a slump in deal values. Thus, economic conditions play an important role in determining the number and size of merger and acquisition deals (Erel et al., 2012).

Deal value of cross border merger and acquisitions (Erel et al., 2012)
Figure 1: The deal value of cross border merger and acquisitions (Erel et al., 2012)

Technological advancement as a country-specific determinant

Innovation is a major factor that encourages cross-border deals. The technologically intensive acquirers set up business units in technologically advanced economies. This improves the research and development operations which in turn affects the level of innovation within the business domain. This innovation, in turn, generates long term growth prospects for the business. In addition to this, international M&A has spillover effects. The adoption of superior technologies by multi-national firms brings in technological advancements for the domestic industry. Therefore, firms often prefer to merge with other cross border organizations with a high level of research and development innovations and technological advancements. (Lebedev, Peng, Xie, & Stevens, 2015).

Premium and shareholders protection as a determinant

Premiums are stock’s closing price before the announcement of the deal of merger. Countries with a higher level of shareholder protection often set up high premiums (Malik, Anuar, Khan, & Khan, 2017). Acquirers prefer to set up industries in countries with a high level of shareholder protection. A higher level of shareholder protection reduces the cost of capital. In addition to this, it allows the acquirer to realize the private benefits of greater control over the investment (Bhagat & Brian, 2008). Thus, the economies that offer a high level of shareholder protection would witness a high rate of M&A with domestic businesses.

The profitability of the business being taken over is a business determinant

In a similar context to the domestic mergers, cross-country M&A occurs with the purpose of profit maximization. This can occur only if the acquisition creates greater production efficiencies. This efficiency is realized by contracting the costs and achieving greater economies of scale. In addition to this, efficiency can also be in terms of business operations. M&A can be used for creating a huge market power. The businesses can charge profit-maximizing prices after the merger. Thus, the profitability of the business activities as an important determinant for cross country M&A (Visser & Nazliben, 2017).

Size of the business as a business determinant

Another important factor that affects the decision to merge or acquire is the size of the business. The size of a business is governed by the book value of the assets. Large business houses often acquire small firms for reaching their target market capitalization. This is consistent with the fact of valuation of the firm prior to and after the merger. This could be affected by the currency movements across countries. Further, the size of the business pre and post-merger could also depend on the size of the deal (Jo, Durairaj, Driscoll, Enomoto, & Ku, 2011).

Industry relativity as a determinant for mergers and acquisition

The decision to merge or acquire is largely dependent upon the industry in which the acquiring business is operating. This determinant may hold a negative or positive direction depending on the goals and objectives of both parties. Businesses develop the potential to diversify business operations could merge with businesses working on complementary goods and expertise. On the other hand, the businesses with the motive of limiting its boundaries within the industry would prefer inter-industry merger or acquisition (Saeed et al., 2016).

Financial performance

The decision to acquire or merge with business largely depends on the financial indicators that affect operational efficiency. In order to examine the liquidity, businesses often use the EBITDA margin. It is widely used to measure the efficiency of the business. In addition to this, the asset turnover ratio is analyzed to measure the value of the assets in the sale. Other such indicators also include the return on assets or the current ratio.  Lastly, the debt to equity is largely used for examining the business’s ability to pay back the liabilities (Malik, Anuar, Khan, & Khan, 2017).

The success of a cross country M&A deal

Cross country mergers and acquisitions have a substantial effect on financial performance. However, the occurrence of mergers and acquisitions could vary in terms of country-wise effects. These effects could emerge because of:

  • corporate governance,
  • economic conditions,
  • technological advancements and,
  • premiums.

A high level of premiums and the technological advancements across the countries could affect the entity’s decision. On the other hand, the business-wise effects could differ in terms of profitability, size, industry, and financial performance. The success of the merger and acquisition depends on the post-merger performance of the interested parties. For this purpose, it is essential to compare the pre-merger and the post-merger performance of the cross-country mergers and acquisitions. Performance could be measured by the extent of change in the profitability of the business.